Speech
Economic Conditions and Prospects

Economic conditions in Queensland have been quite varied over recent years.
In some ways the forces at work have been in parallel to those in the national
economy. On the one hand, the expansion of the mining and gas sectors has driven
strong growth in some of the regions. In the past four years, business investment
in Queensland rose by 75 per cent, totalling $230 billion over
that time and almost $70 billion during 2013 alone. The proportion of
national investment occurring in Queensland has been unusually high.

Investment in the mining sector may now have peaked, but the capacity put in
place is supporting strong growth in exports. Queensland's coal exports
reached record highs over the past year and exports of LNG are expected to
commence in late 2014.

On the other hand, more prudent behaviour by households, after an earlier period
of fairly free spending and borrowing, has kept demand in the urban areas more
restrained.

There was also a marked slowdown in the property sector in the southeast of
the state, perhaps more so than in other states, which has been a dampener
on economic activity. Part of the story here is that in an earlier environment
of fairly easy access to credit, dwelling prices rose too high relative to
incomes in some areas. There was also perhaps, in some instances, too much
construction of the wrong sort of dwelling. Some people involved in or exposed
to the property sector also had too much leverage. When credit conditions tightened
and there were not enough buyers, prices fell and construction slowed down
significantly. After growing at an annual average pace of 12 per cent
between 2002 and the peak in late 2009, dwelling prices in Brisbane fell and
remain around 5 per cent below their peak.

About a third fewer dwellings were constructed in the year to September 2013,
compared with the peak in 2008. Building approvals have been relatively strong
in the resource-exposed regions in recent years, but elsewhere in Queensland
approvals for new detached houses are at around half the 2008 level.

This is something that American members of AmCham who are exposed to the US
housing sector would have also felt over recent years. The US construction
sector, while now established on the path of recovery, is still building only
half the number of dwellings it was at the peak in 2006, and in fact is producing
at two-thirds of the rate of 20 years ago.

At present there are welcome signs that the Queensland housing sector is now
lifting off the bottom. But this has been a long cycle. The price of Brisbane
dwellings was historically about 60–65 per cent of those in
Sydney. At their peak some years ago they reached about 85 per cent
of Sydney levels. Now they are back to about 60–65 per cent
of Sydney levels again. The cycle has taken about a decade. That the cycle
can be so drawn out is a salient lesson, including for those outside Queensland.
Even if a full-blown crisis does not eventuate, as was true of Australia, overdoing
it on housing on the way up is usually followed by a fairly extended period
of working off the problems.

We have heard much of the effects of severe weather on the US economy over the
recent northern winter, with these impacts complicating the task of assessing
the strength of the US expansion. Weather events have also been important in
Queensland in recent years, and some of them have been very costly. Not so
long ago, the problems were those of floods (and indeed some areas of South-east
Queensland experienced flooding over the weekend) but at present much of the
State is in the grip of drought. Crops have been substantially reduced and
the livestock industry will take a number of years to recover from reduced
herds. Farm incomes are estimated to be falling to their lowest levels for
at least three decades. I don't think this will complicate our task of reading
the pace of the national economy as much as in the US case, but these are nonetheless
significant effects in regional economies.

Our discussions with tourism operators, on the other hand, suggest that conditions
have started to improve, partly as a result of the depreciation of the exchange
rate since its peak. Over the year to September 2013, visitor spending in Queensland
increased by more than 4 per cent, which is a little higher than
its average historically. Tourism operators have also been tailoring their
services to suit rapidly growing segments of the market, including the Chinese
market, which grew by 25 per cent over the year to September 2013.

Speaking of tourists, there are some rather high-profile visitors coming here
later in the year. For a few days in mid November, the city of Brisbane will
be the focus of the world, when the leaders of the G20 come to town. I'm
not sure, actually, whether you all know what you're in for! But on the
weekend of 15–16 November, you can expect the biggest gathering of global
leaders ever assembled in Australia to be in your city.

Australia can host this meeting with a strong reputation for economic performance.
While you might not know it from the tone of much domestic discussion, most
– if not all – of the G20 membership looks at our relative growth,
financial stability, banking soundness and public finances with a good deal
of admiration. This has given Australia, at the margin, just a little bit of
additional credibility in putting forward our agenda.

Just what is that agenda?

In essence, it is about growth. The Australian presidency of the G20 is focused
on trying to improve global growth, with a focus on enabling investment, including
infrastructure investment, and enacting structural reforms to raise the potential
growth of the economies of the G20. At their meeting in Sydney in February,
the G20 Finance Ministers and Central Bank Governors agreed to come to future
meetings with proposed policies that would have the effect of lifting the level
of the G20's collective GDP by a little over 2 per cent by the
end of five years.

Let me be clear what this means. The goal is that the level of real GDP in the
G20 is 2 per cent (actually a little over 2 per cent) higher
by the end of five years. That could be achieved by lifting the rate of growth
by 0.4 per cent per year in each year, or by a little more than that
in the out years if the reforms take longer to have their effect, which they
probably would. It doesn't mean growth is 2 percentage points higher in
each year (that would be a very big effect indeed).

Just in case you think this doesn't sound like such a big deal, let's
contemplate the magnitudes. Were the 2 per cent aspiration to be
achieved, it would mean something of the order of US$2 trillion of additional
output in the world economy, something like 15 million extra jobs spread around
the G20 countries, and hundreds of billions of dollars of additional revenue
for governments. It's serious money.

Let's also be clear what this doesn't mean. This goal is not to be achieved
by clever programs of cheap money devised by central banks. Nor is it to be
the result of fiscal adventurism. We are trying to shift the conversation away
from the ‘growth versus austerity’ framing of recent years, which
is ultimately a rather sterile discussion. No-one has ever achieved growth
simply by austerity, but equally the approach of simply ignoring the gaping
hole in public finances in many countries has reached the limits of its credibility.
We need a refocused conversation, around doing things that spur growth potential,
which would mean, among other things, that the accommodative policies of central
banks could get more traction.

These things are, however, demanding. There is something of a tendency for governments,
when asked to outline their growth plans, to list the things that they already
want to do for political reasons, and then to claim that they will help growth.
Some of those things may well help growth, but in fact many of the things that
are needed to spur growth seem not to make it onto such lists. Things that
boost competition in markets, that genuinely free up trade, that reform the
governance and financing of infrastructure projects (and the pricing of use
of infrastructure), that put retirement income streams on a sustainable footing,
that re‑align incentives, that allow exchange rates to be more market
determined, that encourage labour market mobility and participation, that enhance
human capital, and that minimise distortions from tax – many of these
often don't make in onto ‘to do lists’ in the way that perhaps
they should.

So there is some hard thinking to do. Time will tell whether the countries of
the G20 will rise to the challenge. But if not now, when?

These issues are very real ones for Australia. For we face considerable challenges.
In saying this, I am not referring to the short-run ones, to do with the ‘handover’
from mining to non-mining investment, as difficult a challenge as that is at
present.

By now the proverbial pet shop residents are all talking about this: where will
the growth come from after the mining investment boom ends? I suspect that
plenty of the people who never thought the mining boom would do much to boost
growth are among those asking the question of what will replace it as a source
of growth.

I've spoken about this a good deal in other speeches, so I will not repeat
the detail today. If we manage to absorb the upward phase of the biggest terms
of trade boom in more than a century without overheating, and the downward
phase without a slump, that would be a major achievement. We have, by and large,
managed the first part and there are some promising early signs that things
may turn out not too badly in the second. But early signs are just that: early.
It is far too soon to think about counting any chickens yet. Let's also
be clear that the capacity to fine-tune these outcomes is very limited.

Most importantly, for today's discussion, even if we do manage this episode
as successfully as we might dare hope, major long-run challenges will remain.
These are the things I want to highlight today, two of them in particular.

First, fiscal sustainability. The debate here has, I would have to say, been
overly- focused on budget outcomes in particular years. The real issues are
medium-term ones. Put simply, there are things we want to do as a society,
and have voted for, that are not fully funded by taxes over the medium term,
as is starting to become clear in the lead up to the May budget. Here I refer
to the very important speech given last evening by my colleague, Treasury Secretary,
Martin Parkinson.[1]
Our situation is not dire by the standards of other countries but neither are
the issues trivial. A conversation needs to be had about this.

Second, demographics. More people will be moving into retirement, and fewer
people entering the workforce, over the years ahead.

Our regular discussion doesn't pay much attention to this. It's understandable
that with very public announcements of job losses – albeit many of them
several years into the future – people become worried about jobs. They
ask: where will future jobs come from?

There are two things to say. One is they will come from areas we don't see
yet. In the middle of 1991, at the low point of the last serious recession,
people were very pessimistic about future employment prospects. The rate of
unemployment was in double digits.

But today, over 20 years later, there are nearly 4 million more jobs in the
economy than there were then. The rate of unemployment, even though it has
gone up recently, is just slightly more than half what it was at its peak in
the 1990s.

It's worth noting that none of those additional net jobs came from manufacturing.[2]
The manufacturing sector in fact shed about 100,000 jobs over that 20-year
period. But other sectors increased their employment. Mining employment tripled
and that alone more than offsets the reduction in manufacturing, without taking
into account the growth in construction, health care and a number of other
services sectors where the number of jobs has roughly doubled. As of today,
even with some recent weakness, there are more jobs in the economy than ever
before.

The second thing to say is that, cyclical things aside, the more likely problem
in the medium-term future won't be one of not enough jobs, but instead,
not enough workers. At present the number of new entrants to the labour force
after finishing education each year exceeds the number retiring. Ten years
from now those numbers could be roughly equal, absent a further rise in labour
participation in the older cohorts. The question will be less ‘where
will the jobs come from?’ and more ‘where will the workers come
from?’ It's true that migration adds to the workforce as well, though
migration also adds to the number of people not working and retiring.

So demographic trends point in the direction of a smaller proportion of the
population working, and a larger proportion needing support in their later
years, even as other demands on the public finances for the provision of social
goods increase.

That looks like a pretty uncomfortable combination of trends. How do we reconcile
them?

The answer – the only answer – is growth. To some extent we will,
hopefully, be able to lessen the problem through higher labour participation,
for longer. But most of all we will need higher productivity of those working.
That means making the system as flexible as possible and as encouraging as
possible to innovation.

That's why the G20 agenda is very pertinent for Australia, notwithstanding
that we have enjoyed 20 years of reasonably steady growth. I dare say it is
for the United States too. We are not just talking idly about other countries
lifting their growth as an intellectual exercise. We are asking how to lift
our own trend growth performance.

For Australia, one potential source of productivity improvement lies in the
very fact that across a range of sectors the level of US productivity is much
higher than our own. There may be various reasons for that, some of which we
may be unable to emulate. But it's hard to believe that there are not some,
possibly substantial, ‘catch-up gains’ available to us by adopting
better practices.

For the United States, it is in some ways harder because generally it is the
productivity leader, so ‘catch-up’ is not available. Observers
have differing views about the ability of the United States to push up its
own productivity growth in future. My own view is that the United States remains
an immensely innovative society, which I think is ground for cautious optimism.

In the end, increasing the potential growth of the G20 economies, and our own
economy, is a challenge of the first order. The ‘2 per cent’
goal, while subject to uncertainty and based on numerous assumptions and so
on, nonetheless will hopefully force us all to confront the right set of questions.

Before I finish, it is appropriate, particularly given the Financial System
Inquiry now under way, to mention the role of finance in supporting growth.
The Reserve Bank has made a submission[3]
to the Inquiry. It points out that there are a few essential things that we
want a financial system to do.

They are to:

provide a way of exchanging value (i.e. payments services)

transfer resources between savers and investors (intermediation), with appropriate
monitoring

transfer, price and manage risk

provide liquidity services.

Over the past couple of centuries, the provision of such services has contributed
to the accelerated pace of growth of living standards in the market economies.
Recent history has been one of innovation and growth. The development of new
products, efficiencies in process, and the use of information technology all
held promise. They still do. Unfortunately, and this is stating the obvious,
the problems that developed in the international financial system, due to serious
shortcomings in key markets and institutions in some of the world's most
important economies, have meant that finance has, globally, too often been
growth-reducing over the past five years. Moreover, we have to question, in
hindsight, the basis of some of the apparently easy growth for a few years
before the crisis broke.

The world learned, or rather re-learned, the lesson that finance has its own
cycle – of risk-seeking and then risk-aversion; of leverage and de-leveraging;
of confidence, then over-confidence followed by fear or even panic. The financial
system is capable of providing support for the economy and of helping it absorb
shocks. But it is also capable of being a source of shocks itself.

That being so, it is not surprising that, internationally, the focus since 2008
has been one of repair, re-thinking and regulatory reform. It remains a big
part of the G20 agenda, with some important milestones to be passed this year.

In Australia, our crisis experience was not as wrenching as for some other places.
Our supervisory framework stood up to the test. Our key institutions proved
to be robust and generally prudent behaviour of our financial institutions
stood us in good stead. Nonetheless, there were lessons to be learned, and
adjustments to be made, both for supervisors and financial institutions. It
is very much in our interests to absorb the lessons, and to make the sensible
changes, including those that are part of international standards.

The Inquiry offers the opportunity to distil those lessons, and also to contemplate
the future. A financial sector that reliably and efficiently offers the services
the community needs – the ‘handmaid of industry’ –
is a boon to growth and prosperity, and can play an important role in achieving
the growth we want to see.

That doesn't mean there were no new jobs in manufacturing – there undoubtedly
were as the sector found things to do that it wasn't doing before, even
as things it had been doing became uneconomic and those jobs were lost. I
suspect, though I cannot prove, that many of the jobs in manufacturing today
did not exist 20 years ago. But in net terms the number of people in manufacturing
declined by around 10 per cent since mid 1991.
[2]